Shares of Subex Azure Ltd’s did well to close just 12.6% lower after it announced a 32.9% reduction in its profit forecast for the year. Just prior to the announcement, Subex traded at 11.5 times estimated profit for financial year 2007-08. It now trades at 15 times revised earnings.

It probably helped that in a conference call late last week, the company’s management did a good job of reassuring analysts that the negative impact was restricted to one client and that growth rates continue to be healthy. To be sure, both UBS and Merrill Lynch have retained their buy ratings on the stock even after the guidance revision. Besides, the profit forecasts do not include an extraordinary forex related gain of Rs35 crore Subex made in the June quarter. Assuming that there are no further gains/losses on account of forex fluctuations, profit estimates are lower by 26.8%.

But these aren’t the only reasons the stock fell at a relatively low rate. In the preceding six trading sessions, Subex’s share price had already fallen more than 14% at a time when the CNX IT index fell by less than 5%. Including this, its value has declined over 25%, almost in line with the earnings downgrade.

It’s interesting to note that although Subex’s revenue guidance was revised downward by 15% in rupee terms, earnings would be impacted by as much as 33%. This is to do with the non-linearity of the products business, where most costs are fixed. Most of the $20 million Subex had assumed in its revenues was expected to flow into the bottomline. In fact, the company would have to tighten selling, general and administrative expenses in order to restrict the impact on profit to $12 million.

If Subex manages to meet its revised guidance, its operating margin would have increased from 19% in FY07 to 31.5% this fiscal. This speaks of speedy integration of the company’s acquisitions. What’s more, even after the downward revision in profit and assuming a 40% dilution in the company’s equity (post-FCCB and warrants conversion), Subex’s earnings per share will be maintained above last year’s levels. Also, the withdrawal of orders is being seen as a one-off event, and is not expected to have wider ramifications.

It’s for these reasons that analysts continue to be bullish on the stock. But the company would now have to deliver on its revised promises for the markets to turn bullish again.

Aban Offshore

Last week, Aban Offshore Ltd announced that it would acquire a semi-submersible rig for a consideration of $211 million (Rs850 crore) from Bulford Dolphin Pte. Ltd. Analysts at Emkay Research have said that assuming the rig gets operational by April, Aban’s earnings estimates for financial year 2008-09 would be upgraded by 11%. The Aban Offshore scrip, however, has risen by around 1.5% since the announcement. Even this was due to the announcement that it has a firm order worth Rs2,000 crore to be executed over the next three years. Analysts say that an order from ONGC for three rigs was already factored in.

Aban Offshore shares have more than doubled this year, on the back of a substantial increase in the company’s rig fleet, on the one hand, and a rise in rates, on the other. What’s more, the good times are expected to continue. The global rig market has recovered sharply from 2004-05, thanks to high oil prices, a rise in oil exploration activity and the fact that rig capacity hasn’t increased at a commensurate rate. A large part of the capacity that’s coming up will only help replace old rigs, analysts say. Aban Offshore, Asia’s biggest offshore drilling company, would be among the biggest beneficiaries from the upturn in the sector.

What’s more, Aban has been aggressively expanding capacity by acquiring rigs. Its purchase last year of Sinvest ASA for $446 million led to the near doubling of its fleet size. But it also came at the expense of high leverage – 80% of the acquisition cost was financed through debt. If day rates of its rigs declined, the high leverage could work against the company. But analysts seem to be least worried about such an outcome, at least for the next two-three years.

Macquarie Research points out that there is high visibility for rig day rates for at least the next three years. It adds that Aban is locking in rigs on two-three-year contracts.

However, the high leverage means that of rates were to get better and costs were maintained, earnings would increase exponentially. Other triggers for the stock include the reported listing of Aban’s Singapore subsidiary, which could raise up to $400 million. This could considerably ease the debt-equity position, as well as pave the way for further acquisitions.

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